Evaluation Method

87 that there exists positive but insignificant relationship between long-term nominal interest rate of government securities and budget deficit variables.

Putri, Kuncoro and Sebayang (2015) ascertained whether the effects of fiscal policy credibility, in the form of deficit rule, debt rule, discretionary, and openness, can affect the stability of interest rates using quarterly data in the case of Indonesia during the period of 2001 to 2013. The study applied the ARDL (Auto Regressive Distributed Lag) model in the case in Indonesia. The result shows the debt rule is credible and has an impact on the interest rates in the long term. The short-term discretionary policy tends to increase the interest rates. Odionye and Uma (2013) empirically explored the link between budget deficit and interest rate in Nigeria using Vector Error Correction model (VECM) for the period of 1970-2010. In the long run co-integrating equation, budget deficit reported a positive and significant impact on interest rate implying that a high budget deficit will increase interest rate in the country.

The result supported the Keynesian proposition. Also the evidence from Johansen co-integration result indicated that there is a long run relationship between budget deficit and interest rate.

88 rate in Laos. Kuncoro (2012) ascertained the potential impact of fiscal policy credibility on the exchange rates stabilization in Indonesia over the period 2001-2013. Based on the quarterly data analysis, they found that the impact of credible fiscal policy typically depends on characteristics of fiscal rules commitment. In one hand, the credible debt rule policy reduces the exchange rate fluctuation. In contrast, the deficit rule policy – which is incredible – does not have any impact on the exchange rate and thus does not support to the exchange rates stabilization.

Using a panel data set of 61 countries for the 1951-2007 period, Karras (2011) showed that fiscal policy is indeed more potent under fixed exchange rates than under flexible, and that the difference is substantial: the estimated models implied that maintaining a fixed exchange rate raises the long-run fiscal multiplier by roughly a third. Chatterjee and Mursagulov (2011) determined the mechanism through which public infrastructure spending affects the dynamics of the real exchange rate. Using a two-sector dependent open economy model with intersectoral mobility costs for private capital, results showed that government spending generates a non-monotonic U-shaped adjustment path for the real exchange rate with sharp intertemporal trade-off. The effect of government spending on the real exchange rate depends critically on sectoral composition of public spending, underlying financing policy, sectoral intensity of private capital in production, and relative sectoral productivity of public infrastructure

Parsley and Wei (2014) employed a novel approach to identify exogenous fiscal shocks to provide evidence that exogenous increases in government spending cause real exchange rate appreciations. By focusing on

89 intra‐U.S. real exchange rates and exogenous shocks to state‐level federal fiscal expenditures, and avoid several econometric issues (e.g., endogenous monetary policy, and Ricardian equivalence) which plagued studies using observational data to study the effects of fiscal shocks. Results differ from OLS and suggest that a one standard deviation exogenous fiscal stimulus at home produces a real exchange rate appreciation of about 3.3 percent.

Virtually identical results hold for an exogenous fiscal contraction in the

―foreign‖ state and findings were consistent with simple neo‐classical and Keynesian theory. Monacelli and Perotti (2010) employed Vector Auto Regression (VAR) techniques to estimate the effects of fiscal policy and, in particular, government spending on the CPI real exchange rate and the trade balance in the US and three other OECD countries. Empirical analysis delivers two key results. First, a rise in government spending tends to induce a real exchange rate depreciation and a trade balance deficit, although, especially in the US, the latter effect tends to be small. Second, in all countries private consumption rises in response to a government spending shock and, therefore, co-moves positively with the real exchange rate.

Contrary to widespread empirical evidence, standard NOEM models imply that the real exchange rate appreciates following an increase in public spending, Giorgio, Nistico and Traficante (2016) introduced productive government purchases and shows that the real exchange rate can depreciate after a positive spending shock, thus reconciling the theoretical model with the empirical evidence. Under empirically consistent parameterization, the model implied a depreciation both on impact and in the transition. The transmission mechanism works through an increase in domestic private-sector productivity,

90 spurred by government purchases, which reduce domestic real marginal costs.

Enders, Muller and Schollc (2010) used vector autoregressions on U.S. time series relative to an aggregate of industrialized countries and provided new evidence on the dynamic effects of government spending and technology shocks on the real exchange rate and the terms of trade. To achieve identification, they derive robust restrictions on the sign of several impulse responses from a two-country general equilibrium model. They found that both the real exchange rate and the terms of trade—whose responses are left unrestricted—depreciate in response to expansionary government spending shocks and appreciate in response to positive technology shocks.

Ramasamy and Abar (2015) used bootstrapping technique to increase the sample size to run regression to study the effect the effect of macroeconomic policy on interest rate in United States, Australia and Germany. Results showed that model B was robust which indicated all macroeconomic variables significantly influenced the exchange rates except employment and budget deficit. Most of the macroeconomic variables showed opposite sign contrary to the expectations and we concluded that the psychological factors like investor confidence dominate over economic variables in deciding exchange rate fluctuation. Okoye, Evbuomwan, Modebe and Ezeji (2016) explored the relationship between the performance of key macroeconomic indicators (exchange rate, inflation rate, gross fixed capital formation and unemployment) and fiscal deficits. Data on the research variables covering the period 1981-2014 were sourced from the publications of the Central Bank of Nigeria (CBN) and the National Bureau of Statistics (NBS). Employing the econometric methodology of the vector error correction

91 model (VECM), the study showed significant positive effect of gross fixed capital formation as well as significant negative impact of inflation rate and unemployment on fiscal deficits in Nigeria. Though, there is evidence of negative effect of exchange rate, the study shows it is not significant.

Gülcan and Bilman (2005) investigated the effect of budget deficit reduction on exchange rate between US dollar and Turkish lira (TL). Co-integration method and causality tests were used in order to find out the possible effects of budget deficit reduction on exchange rates during the period of 1960-2003 in Turkey. Long run relationship between budget deficits and real exchange rates reveals that when the share of budget deficits in GDP increase by 1 percent, real exchange rates will increase by 288,023 points.

Castro and Fernández-Caballero (2011) analysed the impact of fiscal shocks on the Spanish effective exchange rate over the period 1981-2008 using a standard structural VAR framework. They showed that government spending brings about positive output responses, jointly with real appreciation. Such real appreciation was explained by persistent nominal appreciation and higher relative prices. The results indicated also that the adoption of the common currency has not implied any significant change in the way fiscal shocks affect external competitiveness through their effect on relative prices. In turn, the current account deteriorates when government spending rises mainly due to the fall of exports caused by the real appreciation.

Asgari (2012) assessed the impact of reducing of budget deficit on the foreign exchange rate. For doing so, ARDL was used in order to find contingency effects of reduction of budget deficit on the exchange rate during 1978-2006 in Iran. The results of evaluation of the economic model in Iran

92 show that there is a long term balanced relationship between budget deficit and foreign exchange. Afonso and Sousa (2009) determined the macroeconomic effects of fiscal policy using a Bayesian Structural Vector Autoregression approach. They build on a recursive identification scheme, but included the feedback from government debt; looked at the impact on the composition of output; assessed the effects on asset markets (via housing and stock prices); add the exchange rate; assessed potential interactions between fiscal and monetary policy; used quarterly data, particularly, fiscal data; and analysed empirical evidence from the U.S., the U.K., Germany, and Italy. The results showed that government spending shocks, in general, have a small effect on GDP; lead to important ―crowding-out‖ effects; have a varied impact on housing prices and generate a quick fall in stock prices; and lead to a depreciation of the real effective exchange rate. Government revenue shocks generate a small and positive effect on both housing prices and stock prices that later mean reverts; and lead to an appreciation of the real effective exchange rate.